Banking reform at the edge of the precipice – the latest news – Report 2

Banker remuneration and FSA’s latest guidance

On 13 October FSA published interim findings on good and poor practice in a ‘Dear CEO’ letter. This applies to institutions irrespective of whether they are participating in the Recapitalisation Fund. It extends beyond directors and senior management and applies to remuneration structures across the bank including traders and many other areas. Banks can expect a further round of FSA visits on this subject before the year-end. Poor practices in relation to the measurement of performance, composition of remuneration and governance are to be eliminated.

FSA’s initial findings following recent thematic visits to banks; the emphasis is on performance-adjusted compensation being deferred and correctly aligned with the risks involved in the business undertaken. At this stage the findings are very preliminary and there is clearly a lot more thinking and analysis required before we can see the final outcome domestically or internationally; it will also be impacted by the more fundamental issues on banking reform which cannot be fully addressed until the current crisis subsides.

For some months now, ‘banker’ remuneration has been criticised by politicians, regulators and the press. This criticism has been seized on by the general public and is now a major political issue both in Europe and the US. It is being looked at by the Financial Stability Forum and FSA is feeding into this process. Much of the public commentary is vague but the pressure for change is only likely to grow as the press focuses on the amount the industry has paid away in bonuses and the escalating scale of tax payer support for the industry and the recessionary impact of the crisis.

The UK Banking Bill

The Banking Bill incorporating the new Special Resolution Regime (SRR) was published and started its passage through parliament. This follows the July consultation and the draft clauses published with it. Many of the critical provisions, which have caused concerns about legal certainty for counterparties of UK banks, will be dealt with in secondary legislation which has not yet been published.

The bill includes new powers relating to the FSCS and compensation arrangements including a power enabling the introduction of ‘pre-funding’ (or contingency funding) of compensation by the industry. If you would like to read our report on the SRR consultation, please click here.

If you would like to read our response to the tripartite consultation, it has been published by HM Treasury here.

Additional links:

Banking Bill
Explanatory Notes

FSCS exposure for banks, insurers and other financial institutions and the implications of the Icelandic crisis

If you would like to read our previous Law-Now report about FSCS limits and capacity please click here.

Last week FSA amended FSCS rules again to increase the current year management levy limit to £1 billion (an increase over recent weeks of over 3,000 %) – this enables the FSCS to impose an industry levy to pay for interest payments (now apparently running at a rate of around £1 billion per annum) on the multi-billion borrowing by the FSCS.

There is still no indication of the potential size of industry levies on banks and other financial institutions (such as insurers) to recoup FSCS compensation (on top of the anticipated levy for interest charges). Gross compensation paid by the FSCS now far exceeds, by several times, the current annual FSCS capacity and levy limits introduced in April 2008 (of approximately £1.8 billion for deposit takers and £2.2 billion for insurers and other institutions), although it is hoped that recoveries from the failed banks will reduce these amounts substantially.

Last week the UK authorities had to deal with the UK impact of the Icelandic banking crisis. This involved Icelandic banks and two of their UK incorporated bank subsidiaries – Heritable (owned by Landsbanki) and Kaupthing Singer & Friedlander (owned by Kaupthing). The subsidiaries were both regulated by FSA and so could be dealt with in a similar way to the Bradford & Bingley rescue under the emergency legislation powers (which will be replaced by the SRR regime to be introduced under the Banking Bill).

Certain retail deposits were transferred (via an SPV established under state ownership) to ING Direct; the sum of these deposits was paid to ING in full, so retail depositors were fully protected, even for balances above the new FSCS compensation limit of £50,000. The payments to ING of about £3 billion were made by the FSCS as deposit protection compensation funded by, further borrowings from the Bank of England, (on top of the £14 billion the FSCS borrowed for the Bradford & Bingley rescue), and by the Treasury for the unprotected balances.

Landsbanki and Icesave

Landsbanki, the Icelandic parent bank of Heritable, operated a UK branch under the Icesave brand. Iceland is not part of the EU but is an EEA member; as a result, the bank used its Icelandic banking authorisation to ‘passport’ into the UK and to operate a deposit taking UK branch without having to obtain a UK banking licence. The regulation of solvency was a matter for the Icelandic authorities and not for FSA; depositors were potentially protected both by the Icelandic scheme and by “top up protection” under the FSCS where its limits are higher.

The UK authorities were not in a position to mount a rescue of an Icelandic bank. As a result of concerns about the position of UK depositors versus Icelandic ones, the UK imposed a Financial Sanctions Notice (which are normally used for imposing sanctions on terrorists) to freeze UK assets of the bank. This was intended to help protect the UK wholesale depositors which would not be eligible for FSCS or UK state funded compensation; it transpired that this included many large deposits by UK local authorities, health trusts and charities.

The UK authorities announced that all retail depositors in Icesave would be repaid in full. The potential FSCS liability (and therefore the liability of FSCS levy payers) is unclear; the position is complicated by the potential recovery of compensation under the Icelandic protection scheme and the additional compensation liabilities, above FSCS limits, taken on by the UK Treasury.

Additional links:

HM Treasury Statement on Icesave & Heritable
FSA Statement on Icesave
Heritable Order
Transfer of Heritable’s deposits to ING Order
KSF Order
Freezing Order (Landsbanki) 1
Freezing Order (Landsbanki) 2